Regulating banks is not so easy

Many of us blame the FSA and the Bank of England for the banking crisis that has brought such turmoil into our working lives. They should have spotted the reckless behavior of bankers before it got out of hand and nipped it in the bud years ago.

Really?

It’s easy to bash regulators. But it’s not so easy to be one.

Banking regulation is a difficult balancing act because your number one priority is to ensure banks don’t go under. Yet banks by the nature of what they do are always technically bankrupt.

To be bankrupt means you are unable to pay short term debts as they fall due.

Banks borrow short term and lend long term. At any point in time they are always technically bankrupt, because they are unable to pay all their depositors at once, because of the maturity profile of their assets. The only thing that actually stops banks from going bankrupt every day is confidence in the banking system. And the job of the regulator is to maintain confidence in the system. So the Bank of England, when it was in charge, had sensible rules that had been developed over hundreds of years to safeguard depositors’ assets — to make sure that our money was rarely put at risk

Some of these rules were just plain common sense: don’t lend over three times a borrower’s income; keep sufficient general reserves to allow you to cope with bad times; pay bonuses only out of profits not out of revenues; and the golden rule — don’t invest in anything you don’t understand.

In 2007, when the credit crunch began to unfold, not one of these basic common sense rules was being followed at any major bank.

The greed refers not just to bankers’ unrelenting search for profits, but also to our own individual craving for more credit, more material goods and more instant gratification.

The global nature of banking flows means that many bankers have been able to profit from regulatory arbitrage: shifting business activity to jurisdictions where regulation was more lax. For some financial products, it was London itself that had the most lax regulatory environment.

Bad regulation stemmed in part from Gordon Brown’s weakening of the Bank of England in 1997 and his creation of a tripartite structure involving the Treasury, the Bank of England and the Financial Services Authority. Regulation by committee gave banks a license to run wild, slipping through the gaps between these three bureaucratic institutions. Then, of course, there is the small matter of competence. Regulators simply do not understand all the new banking products that have been emerging with alarming speed. It’s not because the products were particularly complicated or that regulators are particularly stupid — although both are undoubtedly true. It’s because banking itself had become too complex for any one human brain to comprehend.

But by far the biggest problem the typical regulator faces is exerting authority over the bankers themselves. Let’s put it this way, how do you give orders to someone who is taking home 100 times what you make? It kind of saps your confidence in the system, don’t you think?